"They Are Going to Have to Call on Bernanke"

George Melloan takes a look, in today's WSJ, at the current financial markets and the money that will be needed to fund the "stimulus" package, and he reaches one conclusion:

The Obama administration and Congress will call on Ben Bernanke at the Fed to demand that he create more dollars -- lots and lots of them.

What will happen as a result of this money printing madness? Melloan answers this question:

Well, the product of this sort of thing is called inflation. The Fed's outpouring of dollar liquidity after the September crash replaced the liquidity lost by the financial sector and has so far caused no significant uptick in consumer prices. But the worry lies in what will happen next.

Melloan gets the inflation part correct, but then believes this will automatically lead immediately to stagflation:

Inflation is the product of the demand for money as well as of the supply. And if the Fed finances federal deficits in a moribund economy, it can create more money than the economy can use. The result is "stagflation," a term coined to describe the 1970s experience. As the global economy slows and Congress relies more on the Fed to finance a huge deficit, there is a very real danger of a return of stagflation

In our book this is a fundamental misunderstanding of stagflation. Stagflation occurs when the Fed prints enough money to fuel inflation, but not enough to force the economy completely in the direction of a distorted consumption/savings ratio. Because the Fed printing ultimately leads to inflation, more and more new money needs to be printed to flood the economic structure in a fashion to distort it in favor of the capital goods sector. If you need 15% money printing to support the distorted structure, but the Fed is only printing 10%, that will result in inflation and recession, i.e., stagflation.

At the present time, the Fed's double digit money printing appears to be more than sufficient to support a distorted capital structure, which will mean inflation and a climbing economy and stock market.

The Nobel Prize winning economist, Friedrich Hayek, who coined the term stagflation, understood this. Inflation itself, when it is powerful enough, will fuel the stock market higher. He said as much in his interview in 1975 on Meet the Press. Equities were the best hedge against inflation, he said. The 1970's, however, did turn into a period of stagflation, as the Fed printed money, but not enough to support the distorted capital structure. Thus, you had recession and inflation. The current period, at least in the short-term, appears to be a period when the Fed printing will be sufficient to support the distorted capital structure and thus, the current period is likely to be a better fit for Hayek's advice, then when he initially gave it in 1975.